May brought renewed optimism, with mostly positive developments in financial markets and the broader economy, driven by easing trade tensions and encouraging economic data. While structural concerns—such as U.S. fiscal sustainability, international tensions, and evolving interest rate dynamics—remain in focus, markets generally responded favorably to signs of stabilization, including tariff de-escalation, stable employment numbers, cooling inflation, and earnings that exceeded projections.
In this edition of Insights, we review three key developments shaping the current investment landscape:
- The evolving environment around tariffs and trade policies
- The rising S. deficit and its impact on interest rates
- The growing economic impact of artificial intelligence (AI)
Market Performance: Bonds Faced Headwinds, Equities Accelerated
While bonds declined in May, pressured by concerns over rising interest rates and government debt, equities rallied, buoyed by improved trade sentiment and robust global earnings.
Globally, fixed income fell by 0.36% in May, primarily driven by weaknesses in the world’s two largest bond markets: the U.S. and Japan.
- U.S. Taxable Bonds declined by 0.72%, negatively impacted by Moody’s downgrade of the U.S. government’s credit rating, which was prompted by rising debt levels.U.S. Tax-Exempt Bonds posted a modest gain of 0.06%, supported by more favorable tax provisions in recent legislation.
- Floating-rate loans rose 52%, benefiting from fading recession concerns and steady short-term interest rates.
- International Bonds dipped 12%, driven in part by a significant decline in the Japanese bond market following the prime minister’s expression of concern about fiscal stability.
Collectively, equities in the U.S. and abroad rallied by 5.75% following positive tariff-related announcements between the U.S. and key trading partners, including the United Kingdom and China, as well as strong corporate earnings.
- U.S. Large-Cap Equities climbed 6.38%, lifted by trade progress and strong performance in technology. May was the asset class’s best month since November. Signs of improved trade negotiations lifted investor sentiment. In addition, the first-quarter earnings season proved better than expected, with S&P 500 earnings growth reaching 13.3% compared to the anticipated 7.2% at the end of the quarter.
- U.S. Mid- and Small-Cap Equities rose 5.72% and 5.34%, respectively, amid improving inflation and rate expectations.
- International Equities continued to be the best-performing asset class year to date for investors in 2025, with international large-cap and emerging markets up 4.58% and 4.27%, respectively, for the month, boosted by earnings and trade expectations.
Trade Policy: A Moving Target
April’s abrupt “Liberation Day” tariff announcements rattled markets. These sweeping measures included a 10% levy on nearly all imports and additional reciprocal measures on various trading partners. The breadth and abruptness of the policy far exceeded market expectations, triggering an immediate and dramatic sell-off.
However, markets recovered as the policy narrative evolved, and a series of exemptions and targeted trade negotiations softened the initial blow. The categories exempted or partially excluded included:
- Electronics such as semiconductors, smartphones, and computer components,
- USMCA-qualified goods like those that fall under the United States-Mexico-Canada Agreement, and
- Pharmaceuticals, which are critical to supply chain stability.
In early May, the U.S. and the U.K. announced an agreement aimed at strengthening bilateral trade relations and boosting economic integration. The deal focused on lowering the tariff rate between the two countries. By the middle of the month, the U.S. and China also agreed to roll back tariffs on each other’s goods by 115% for an initial 90-day period.
These changes suggested that a more pragmatic and negotiated approach to trade might prevail, helping to restore investor confidence.
When global trade barriers ease, economic growth accelerates worldwide, as a positive outlook on trade often prompts investors to shift from “safe haven” assets, such as bonds or gold, into stocks. Cyclical sectors, in particular, tend to outperform, and emerging markets—many of which are export-dependent and rely on access to larger consumer markets, such as the U.S. and Europe—can unlock substantial growth.
In our view, this remains a complex and evolving situation that we are monitoring closely.
Deficit Pressures and Rising Yields
Toward the middle of the month, Moody’s became the last of the three major credit rating agencies to downgrade the U.S. government debt, citing unsustainable fiscal trends, particularly lawmakers’ reluctance to make difficult decisions regarding the nation’s finances. Although long anticipated — S&P and Fitch issued similar downgrades in 2011 and 2013 — this move renewed focus on long-term budget discipline.
Investor concern further intensified with the initial passage of the One Big Beautiful Bill Act (OBBBA), which the Congressional Budget Office estimated will cost the government $2.5 trillion over the next 10 years.
An increased U.S. deficit means increased government borrowing and can lead to elevated bond yields. For example, to attract buyers for this higher level of issuance, the government is expected to offer higher interest rates. As a result, Treasury yields pushed higher in May:
- The U.S. 10-year Treasury yield surpassed 4.5% for the first time since February.
- The U.S. 30-year Treasury yield exceeded 5.0%.
We continue to believe that there is investment merit in holding U.S. fixed-rate debt in the event of deteriorating economic conditions, as bonds are typically effective diversifiers during equity drawdowns.
However, our approach to diversification remains a critical part of your portfolio, as it incorporates exposure to less interest-rate-sensitive fixed-income instruments, such as short-duration high-yield and floating-rate loans, alongside modest exposure to global bonds, where appropriate.
We expect the U.S. debt situation and associated fiscal challenges to be top of mind throughout the summer.
AI Investment Driving Economic Growth
Artificial intelligence is no longer a theoretical driver of productivity; it is now a material contributor to economic growth. In the first quarter of 2025, data center construction alone added a full percentage point to U.S. GDP growth. In our view, this foreshadows a powerful, multi-year tailwind for the U.S. economy.
In their Q1 2025 earnings calls, several leading technology companies prominently cited AI investment as a key driver of current performance and future strategy. Here are some notable examples from three of the most valuable public companies in the U.S.:
- NVIDIA (NVDA): As the world’s largest company, NVIDIA consistently highlights the overwhelming demand for its AI infrastructure. CEO Jensen Huang reported record data center revenue of $39.1 billion.
- Microsoft (MSFT): CEO Satya Nadella stated that for Microsoft, a primary cloud provider and leader in AI services, “cloud and AI are the essential inputs for every business to expand output, reduce costs, and accelerate growth.”
- Alphabet (GOOGL): Google’s parent company, Alphabet, emphasized how its AI investments are starting to pay off. In its Q1 2025 earnings call, CEO Sundar Pichai underscored the company’s “unique full-stack approach to AI” and reaffirmed plans to invest approximately $75 billion in capital expenditures for the full year, primarily in AI and data center capabilities.
In our view, Sage’s broad U.S. equity market allocation provides adequate exposure to AI, allowing for potential gains while maintaining balance and risk awareness should excitement fade. AI is not a niche story – portfolios are invested in innovative companies through broad, diversified equity allocations. All sectors may benefit over time as the new technology diffuses across industries. This helps us avoid narrow thematic bets while ensuring meaningful exposure to transformative technologies.
While these trends have driven lofty valuations, we believe the underlying transformation is real. Companies across sectors are beginning to integrate AI to lower costs, accelerate workflows, and enhance competitiveness. We expect these benefits to be realized over a multi-year period, providing a tailwind for economic growth and company profits in the United States and globally.
Closing Thoughts
Periods like this—where optimism builds amid persistent risks—call for perspective and discipline. We believe clarity and confidence come not from predicting the future but from preparing for a range of possibilities and remaining committed to your investment portfolio strategy. That is why we focus on building diversified portfolios designed to navigate complexity, uncover opportunities, and remain resilient in the face of volatility. Whether through thoughtful fixed-income positioning, global diversification, or exposure to long-term growth trends such as AI, our approach is adaptive by design.
Disclosures
The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks, or estimates in this letter are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks, or assumptions should not be construed to be indicative of the actual events that will occur. These projections, market outlooks, or estimates are subject to change without notice. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, product, or any non-investment-related content referred to directly or indirectly in this newsletter will be profitable, equal to any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer reflect current opinions or positions. All indexes are unmanaged, and you cannot invest directly in an index. Index returns do not include fees or expenses. Actual client portfolio returns may vary due to the timing of portfolio inception and/or client-imposed restrictions or guidelines. Actual client portfolio returns would be reduced by any applicable investment advisory fees and other expenses incurred in managing an advisory account. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Sage Financial Group. To the extent that a reader has any questions regarding the applicability above to his/her situation or any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. Sage Financial Group is neither a law firm nor a certified public accounting firm, and no portion of the newsletter content should be construed as legal or accounting advice. A copy of Sage Financial Group’s written disclosure statement discussing our advisory services and fees is available for review upon request.
